As you can imagine, I'm a big fan of Joel Greenblatt's Magic Formula® Investing strategy.
There is a certain "complex simplicity" to the method.
The real brilliance, in my opinion, is the utilization of earnings yield, or EBIT (earnings before interest and taxes) divided by enterprise value (market cap minus net cash or plus net debt). This is far better than the standard price-to-earnings (P/E) ratio for a few reasons. For one, it integrates the health of the balance sheet right into a single valuation metric. And secondly, it gives a percentage number to compare against alternative investments like bonds, annuities, or CDs.
The Magic Formula ranks all stocks by earnings yield and also an adjusted return on invested capital calculation. Score by each statistic, add up the scores, and the lowest scores are screened. Voila, a simple but useful list of the stock market's cheapest, most efficient companies!
We've added a few other statistics to further help investors choose Magic stocks. The free cash flow yield looks at free cash flow - the most important metric in business - instead of reported earnings to determine how "cheap" a stock is. We've also gathered 3 year average revenue growth to find stocks that are not only "cheap" and "efficient", but also "growing".
Today, I want to introduce 3 new additions to the MagicDiligence site to help investors find even more attractive stocks using Greenblatt's ingenious but simple statistical filters.New Addition #1: Stock Statistics Distribution List
Wouldn't it be cool to know which stocks ranked in the top 20% (or bottom 20%, etc.) of the market for each "Magic" statistic? For example, recent studies have shown that ranking the market's stocks by simply earnings (or free cash flow) yield generates substantial outperformance, without even considering ANYTHING else?
Heck, Greenblatt himself has embraced this method in his latest book, The Big Secret for the Small Investor, and has even set up mutual funds around simply buying stocks ranking in the top percentiles of the market for valuation!
MagicDiligence's newest tool, the Stock Statistics Distribution, allows you to see the market's stocks grouped by percentile for a variety of statistics including earnings yield, free cash flow yield, return on invested capital, and average 3 year revenue growth. Want the top 20% by earnings yield? Easy. Want to see top 20% fastest growing stocks in the market? No problem. Interested in shorting and want to see the bottom 20% of stocks by free cash yield? You can do that.
Each 20% grouping is given a color and a group name. For example, the 40-60% percentile grouping is considered "Average" and colored black. This is important as we utilize these distributions across the site now. Which leads us to...New Addition #2: Accurate Analysis of Statistical Values
However, these were always hard-wired based on experience. It did not account for moves in the market. For example, in a down market, an earnings yield of 9% might be "Average", while in an up market, 9% would almost certainly rank as "Very High".
Now, all stat values will be evaluated as to where they rank relative to the market. For example, if a 9% earnings yield ranks in the top 20% of all stocks, it will be color coded dark green and a hover will display "Very High". The color codings and hover comments are designed to match the Stock Statistics Distribution for consistency.
These color codings and comments are implemented across the site in all tables and in the "Instant Diligence" section of the Single Stock Stats Calculator.New Addition #3: The MagicDiligence "Star List"
With the ability to group stocks by various statistics, a natural question arose:
Which stocks rank highly relative to the market in *all* of the statistical categories?
This is an exciting question. The ability to find stocks that are in the top 20% of the market in earnings yield, free cash flow yield, return on capital, AND average 3 year revenue growth is compelling. Quantitatively, these are the cheapest stocks of the most efficient, fastest growing companies in the entire stock market!
And now we have it... the MagicDiligence Star List!
This list will be updated daily and I plan to track the one-year performance of these against the market in the future. It will be interesting to see if these stocks really do represent the best-of-the-best investment opportunities from a mechanical perspective.Try Them Out!
Both the Stocks Statistics Distribution and MagicDiligence Star List are FREE for anyone to try, for a limited time (after which they will be member-only). Let me know what you think and any comments, improvements, problems, etc. If you like, check out our membership offering, with full access to all tools and a new Magic Formula® stock pick every two weeks! Enjoy!